The looming closure of three Australian refineries will affect the security of liquid fuel supplies in Australia. This is particularly so if the government and the oil industry do not devise a joint strategy with which to respond to potential supply disruptions.

Last week, Caltex Australia has written down the value of its two oil refineries (Kurnell in NSW and Lytton in Queensland) by A$1.5 billion. Caltex announced that the results of an operational review due in six months could lead to refinery closures.

The closure may mark another milestone in the decline of Australia’s refining sector. Shell confirmed in July 2011 that it will shut down refining operations at Clyde and convert the Clyde Refinery and Gore Bay Terminal into a fuel import facility by mid-2013. ExxonMobil’s Port Stanvac refinery near Adelaide was mothballed in 2003. In 2009, the decision was made to close down the refinery.

If an ongoing Caltex review results in closure of the two refineries, the nation will be reduced to just four, half the number in 2003.

Caltex’s position also raises questions over the viability of the nation’s four other refineries. Analysts often tout ExxonMobil’s Altona refinery in Melbourne as a candidate for divestment.

There is consensus among industry analysts that it is extremely unlikely there will be any new major additions to Australia’s refining capacity. In fact, BP’s chief economist Christof Ruhl described the future of the local refining industry as “dire”.

Why are Australian refineries closing down?

All of the recent refinery closures have been attributed to the rise of huge refineries in the Asian region, where a surge of new capacity has depressed profit margins in the industry. The closures were not carbon tax related.

Australia’s refineries have experienced declining gross margins for several years, mainly due to competition from foreign refineries, an oversupply of refining capacity in Asia, and the high cost of transporting crude oil to Australia.

Crude oil is transported in large tankers (VLCCs) – up to 200,000 tonnes. Petroleum products are transported in much smaller ships – up to 45,000 tonnes. The freight (per barrel) is cheaper for crude oil via VLCCs. However, this is eroded by the higher cost of refining in Australia which results from smaller scale, higher capital costs, and higher wages and energy costs. Thus, the key problem for Australian refiners is that the landed cost of crude oil in Australia plus refining costs and a profit margin is higher than the landed cost of petroleum products.

Refineries need a production capacity of at least 200,000 barrels per day (bpd) in order to reach the minimum efficient scale. Australian refineries are small in capacity (see table) compared with new refineries in Asia. For example, the world’s largest refinery (Jamnagar in India with the production capacity of 1,240,000 bpd, owned by Reliance Industries) could supply more than Australia’s entire yearly fuel demand.

Powering down: Australia’s oil refineries.

As well as being comparatively small, Australia’s oil refineries are old, with the last refinery built in 1965. Consequently, they require large investment for upgrade in line with evolving environmental standards.

Australia is not unique amongst developed countries in this regard. New oil refineries have not been built in the US since 1976, with more than 30 refineries being closed in the last decade. The story is similar in the UK, with the closure of ten refineries since the late 1970s. The majority of closures have happened in OECD countries and this trend is likely to continue.

The prospects for Australian refineries depend on competitive conditions set by global refinery circumstances. The Australian refining industry operates in an internationally competitive market, with large refinery capacity existing in Asia capable of exporting substantial volumes of fuel to Australia. In this context, importing refined fuel from Asian mega-refineries, such as Reliance Industry’s Jamnagar, ExxonMobil’s Singapore refinery or Shell’s Singapore refinery is more cost-effective for oil companies.

How do refinery closures affect Australia’s energy security?

The total demand for petroleum products in Australia is 941,000 bpd. Consumption of refined petroleum products is projected to grow 1.2 per cent a year over the long term.

Future reductions in refining capacity in Australia (from current 761,500 bpd to 433,000 bpd if only four refineries remain operational) and growth in demand imply that imports will play an increasingly greater role in meeting domestic demand.

According to an Australian Strategic Policy Institute report, the fact that domestic oil production and refining capacity falls short of local demand means that Australia is, at least to some extent, vulnerable to the disruption of supplies of crude and refined petroleum products during times of crisis.

According to the former managing director of Caltex Australia, Des King, “Retaining a substantial oil refining capability is essential to Australia’s energy security.” The closure of domestic refineries will not improve Australia’s energy security in liquid fuels.

Future reductions in Australian refining capacity, coupled with higher levels of demand for liquid fuels, will result in the elimination of spare refining capacity. Domestic refineries will have limited scope to increase production or divert export cargoes into the domestic market in the event of a breakdown. Replacing domestic production losses with imported product may take time to deliver due to the longer supply chains associated with imported petroleum products.

Domestic refineries provide a much greater degree of flexibility in the product supply chain in the event of an unexpected supply disruption. For example, as the major source of imported refined petroleum products to Australia, the loss of refining capacity in Singapore could be the source of significant product shortages in Australia.

The closure of domestic refineries will make Australia more dependent on overseas refiners who may be less responsive to the needs of their Australian customers than would be the case with a domestic refiner. It will also reduce the diversification of supply options available for Australia.

Fast track to dependence.AAP/Dean Lewins

What has been the government’s reaction to closures?

The Australian Government recognised in its 2008 National Energy Security Assessment, that liquid fuel security will decline significantly if the future viability of Australian refineries is challenged and more Australian refineries close.

Yet, as with broader energy policy, the Federal Government has adopted a laissez faire approach to refining. It does not consider refinery closures as a threat to security of fuel supply.

According to the government’s Draft Energy White Paper, a growing reliance on liquid fuel imports is not considered to impair long‐term liquid fuel security due to our ability to import an adequate and reliable supply of liquid fuels through well‐established and diverse international supply chains.

In a statement following Shell’s decision to shut down the Clyde refinery, the Federal Minister for Resources, Martin Ferguson, said the future of the refinery was a commercial matter for Shell and he didn’t have concerns about security of supply.

Yet, analysts suggest that a major disruption to Australia’s oil refining industry would have major consequences not only for the industry but also on society and the economy as a whole. Accordingly, the government and the industry are not adequately prepared to respond to or recover from major disaster or disruption. A substantial reduction in Australia’s refining capacity will cause a major shift in Australia’s liquid fuels supply chain and may have significant security implications if supply disruptions arise.

While the government may not change its laissez faire approach to the refining industry, the possible implications of the decline of Australia’s refining industry require detailed scrutiny in Canberra.

At the very least, a major review of government’s petroleum supply security policy, and industry’s preparedness to deal with potential supply disruptions, is in order as part of the 2014 National Energy Security Assessment process.